Retirement account owners who can finance their retirement years without using their retirement assets may prefer to enjoy the tax-deferred growth offered to retirement plan assets forever. This, however, is not possible, as the IRS eventually wants the deferred taxes on these balances. If you own a Traditional IRA, SEP IRA, SIMPLE IRA, qualified plan account, 403(b) account and/or governmental 457(b) account, and you are age 70.5 or older by the end of the year, you must withdraw a minimum amount from your balance by December 31 of each year. This amount is referred to as a required minimum distribution (RMD). (For background reading, see Strategic Ways To Distribute Your RMD.)
TUTORIAL: Introduction To Retirement Plans
The Required Beginning Date
Recognizing that the retirement account owner may need some time to adjust to this requirement, the IRS provides a reprieve to individuals in their first RMD year. If you reached age 70.5 in 2013, you have, instead of the December 31st deadline, until April 1, 2014, to distribute the 2013 RMD amount from your retirement account. The date of April 1st of the year following the one in which you attain age 70.5 is referred to as the required beginning date (RBD). If your balance is in a qualified plan, 403(b) or 457(b), your employer may allow you to defer the start of your RMD until after you retire even if that occurs after age 70.5. Check with your employer or plan administrator regarding the rules that apply to the plan.
Calculating Your RMD
Calculating the current year's RMD amount for your retirement account is relatively easy. All you need is the value of your retirement account for the previous year-end (your year-end fair market value) and your distribution period, which you can obtain from the IRS-issued life expectancy tables. Your previous year-end FMV is divided by your distribution period to arrive at your RMD amount for the year. For your IRAs, your custodian is required to calculate and notify you of the amount, either proactively or upon you request, provided they had your IRA as of December 31 of the previous year. For qualified plans, your plan administrator should provide the calculation and facilitate the distribution.
Caution: Have your financial professional double check the previous year-end fair market value for your IRA, as there are circumstances under which it may need to be recomputed.
Determining Your Distribution Period
The IRS provides three life expectancy tables (Appendix C),: (1) single life expectancy (table l), (2) joint and last survivor expectancy (table ll) and (3) uniform lifetime (table lll). Table 1 is used only by beneficiaries, and table ll is used by a retirement account owner who has designated a spouse who is more than 10 years his or her junior as the sole primary beneficiary of the account. In all other cases, including those in which there is either no designated beneficiary or a non-person beneficiary, such as a charity, table lll is used to determine the distribution period.
To determine your applicable distribution period, use your age and your beneficiary's age, if applicable, for the year the calculation is being done. For example, if you were born in 1942, your age for 2013 is 71. Unless the sole beneficiary of your IRA is your spouse and he or she is more than 10 years your junior, your distribution period for 2013 is 26.5. This is determined as follows: locate your age on table lll, and the corresponding figure to the right of your age is your distribution period.
Alternatively, assume that your sole primary beneficiary is your 50-year-old spouse. Your distribution period is then determined as follows: locate your spouse's age on the horizontal top bar of table ll (Appendix C), then locate your age on the first vertical bar. Your distribution period is where the two ages meet at right angles within the chart. In this example, it is 35.0. (To learn more, check out Life Expectancy: It's More Than Just A Number.)
What Happens If You Miss Your RMD Deadline
If the RMD amount is not distributed by the deadline, then the IRS assesses a 50% excise tax on the amount not withdrawn. This is referred to as an excess-accumulation penalty. If you withdraw only a portion of the RMD amount, the penalty is assessed on the balance. For example, say your calculated RMD amount for the year is $10,000 and you withdrew $5,000. You will be assessed a 50% excise tax on $5,000. (Get tips on how to avoid the excise tax on Tax-Saving Advice For IRA Holders.)
All Is Not Lost... Maybe
Should you find yourself in the unfortunate predicament of having to pay this excise tax due to an error, you may request a waiver from the IRS. Generally, to consider the waiver, the IRS requires that you submit a letter of explanation asking for a waiver with your income tax return. The excise tax is reported on IRS Form 5329, which may be obtained at www.irs.gov. You may need the assistance of a retirement plan consultant or tax professional with requesting the waiver.
Multiple Retirement Accounts
The IRS permits individuals with multiple IRAs to total the RMD for all the IRAs and distribute the total from any one. As a word of caution, these amounts should be calculated separately for each IRA, as different rules could apply to each. For example, if you have two IRAs, one with your spouse who is more than 10 years your junior as the sole primary beneficiary and the other with your daughter as the primary beneficiary, different tables would be used to calculate the RMD for each IRA.
- Qualified Plans
If you own assets under multiple qualified plans, RMD amounts for each plan must be distributed from each plan. Unlike distributions from multiple IRAs, these amounts cannot be combined.
Similar to RMDs from IRAs, RMDs for multiple 403(b) accounts must be calculated separately, but may be combined and withdrawn from one 403(b) account.
- Roth IRAs
For Roth IRAs, the RMD rules do not apply to the Roth IRA owner. A different set of RMD rules apply to Roth and Traditional IRA beneficiaries. (These are discussed in Inherited Retirement Plan Assets - Part One and Part Two.)
To ensure that your RMD amounts are calculated properly and that you adhere to the general rules, be sure to consult with a competent retirement or tax professional or your financial institution. Taking precautionary steps will help to ensure that you avoid any associated penalties. Also, try to avoid waiting until the last minute to request your RMD, as doing so could result in you missing the deadline by which the amount must be withdrawn in order to avoid penalties.
To continue reading on this subject, see Avoiding RMD Pitfalls.